Does this scenario sound familiar?
Things are going well; you’ve had a great year in business and you know it’s time to expand - but you don’t have spare cash to put the right things in place to do it. So, you approach your bank for a short-term loan to help fund the growth of your business.
Business has been going well for some time - but the bank still says "no".
Why do bank refuse loans?
Banks need to be conservative in what they loan and who they loan to clients. Generally, banks can’t sustain losses of greater than 1% of their loans and still stay in business. Basically - for every dollar the bank lends, they need to get at least 99 cents back.
Banks are highly regulated and their behavior is scrutinized by multiple agencies at both federal and state levels. Banks have strict policies, procedures, and underwriting criteria in place to ensure they meet the standards they are expected and required to meet.
As part of this, they have to be confident that borrowers have three things in place:
- Cash flow
- Personal guarantee
Banks really want (and need) to be paid back, so you have to be able to demonstrate to your bank that you can pay back your loan without question.
It’s also good to have some extra cash on top to be able to cover any possible unexpected contingencies.
If your business is not producing positive, consistent cash flow and there isn’t a good reason why it’s not, banks will have a tough time considering your loan request - unless there are some extenuating circumstances.
In most cases, your bank will require collateral to support your loan if you fail to pay them back.
Collateral can come in the form of real estate, equipment, inventory, and accounts receivable. These are all items that they can, in the case of a default, convert to cash.
Some may be converted to cash quicker than others, but having sufficient collateral is important to most banks.
Certain specialized lenders will lend strictly on cash flow, however, the cost in terms of interest expense and fees for borrowing these funds are generally higher than at a bank.
Most banks will require your personal guarantee and in many cases, your personal net worth can greatly affect your loan request.
If you’re wealthy and have a portfolio of assets that can be readily converted to cash, your banker will definitely treat you a lot better than if your personal balance sheet comes up fairly thin.
Even if you have a very small personal net worth, your personal guarantee will still be required as it is an admission that this is a moral obligation if nothing more.
However, you might have all three of the above in place and still not be successful in your loan request.
The reasons for your loan be refused could be more to do with:
- How you documented your application
- The proposed use of funds
- Your financial history
Many potential objections can be overcome by careful and thoughtful planning.
Approaching your banker when you have assembled all the correct information, and with the knowledge that they will need to complete a full evaluation will help you going forward.
Tried everything but still told "no"?
It may have little to do with you or your business but instead, it could be the industry you are in at the moment, or their feelings about where the country is in the economic cycle.
Consider speaking to other banks in your area that could help support your business. Your present bank may not be able to accommodate your request at this moment - for a multitude of reasons - but another bank could be able to help.
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